Tuesday, September 23, 2008

Crack up: the establishment blues

Management’s disposition to maintain and inflate profits while holding down wages and raw material prices meant that workers and farmers were denied the benefits of increase in their own productivity. The consequence was a relative decline of mass purchasing power. As goods flowed out of the expanding capital plant in ever greater quantities, there was proportionately less and less cash in hands of buyers to carry goods off the market. The pattern of income distribution in short, was incapable of long maintaining prosperity.

The Crisis of the Old Order – Arthur Schlesinger

Chris Dodd today called Henry Paulson’s bailout a Constitutional crisis as much as a financial one. The Goldman Sachs plan seeks to effectively give $700 billion to one man with no oversight, whether it Congressional or Judicial. The crisis looks increasingly like another executive power grab on par with the Patriot Act except this time using the Treasury Department as a surrogate of “change”. To add insult to the situation it looking like Paulson has been crafting this plan for months as cited by a Bush surrogate today.

A string along perhaps as the summer’s $300 billion bailout for mortgages hasn’t stopped the hemorrhaging.So what does any of it mean?

I’m no economist and trying to get answers in laymen terms is not so easy. However I think these are helpful perspectives that speak to deregulation and economic policies that are the backbone of this mess.

This is a good back history on Washington and Wall Street through the years.

And that's the point. At moments of crisis since the mid-1980s, the relationship between Washington and Wall Street has changed fundamentally, at least when compared to anything that would have been recognizable in the previous century. As a result, the road ahead is dark and unknown.

During the nineteenth century, Washington was generally happy to do favors for Wall Street financiers. Railroad tycoons, who often used those railroads as vehicles of extravagant speculation, enjoyed subsidies, tax exemptions, loans, and a whole smorgasbord of financial fringe benefits supplied by pliable Congressmen and Senators (not to mention armadas of state and local officials).

Since the political establishment was committed to laissez-faire, legerdemain by greedy bankers was immune from public scrutiny, which was also useful (for them). But when panic struck, the mighty, as well as the meek, went down with the ship. Washington felt no obligation to rush to the rescue of the reckless. The bracing, if merciless, discipline of the free market did its work and there was blood on the floor.

By early in the twentieth century, however, the savage anarchy of the financial marketplace had been at least partially domesticated under the reign of the greatest financier of them all, J.P. Morgan. Ever since the panic of 1907, the legend of Morgan's heroics in single-handedly stopping a meltdown that threatened to become worldwide, the iron discipline he imposed on more timorous bankers, has been told and re-told each time an analogous implosion looms.

As it turned out, though, the days of Washington agnosticism about Wall Street were numbered. The economy had become too complex and delicate a mechanism and, in 1907, had come far too close to meltdown -- even Morgan's efforts couldn't prevent several years of recession -- to leave financial matters entirely in the hands of the private sector.

First came the Federal Reserve. It was established in 1913 under President Woodrow Wilson as a quasi-public authority meant to regulate the country's credit markets -- albeit one heavily influenced by the viewpoints and interests of the country's principal bankers. That worked well enough until the Great Crash of 1929 and the Great Depression that followed and lasted until World War II. The depth of the country's trauma in those long years vastly expanded the scope of Washington's involvement in the financial marketplace.

President Franklin D. Roosevelt's New Deal did, as a start, engage in some bail-out operations. The Reconstruction Finance Corporation, actually created by President Herbert Hoover, continued to rescue major railroads and other key businesses, while some of the New Deal's efforts to help homeowners also rewarded real estate interests. The main emphasis, however, now switched to regulation. The Glass-Steagall Banking Act, the two laws of 1933 and 1934 regulating the stock exchange, the creation of the Securities and Exchange Commission, and other similar measures subjected the financial sector to fairly rigorous public supervision.

This lasted for at least two political generations. Wall Street, after all, had been convicted in the court of public opinion of reckless, incompetent, self-interested, even felonious behavior with consequences so devastating for the rest of the country that government was licensed to make sure it didn't happen again.

The undoing of that New Deal regulatory regime, and its replacement, largely under Republican administrations (although Glass-Steagall was repealed on Clinton's watch), with what some have called the "socialization of risk" has contributed in a major way to the mess we're in today. Beginning most emphatically with the massive bail-out of the savings and loan industry in the late 1980s, Washington committed itself, at least under conditions of acute crisis, to off-loading the risks taken by major financial institutions, no matter how irrationally speculative and wasteful, onto the backs of the American taxpaying public.

Despite free market/anti-big-government rhetoric, real-life Washington has tacitly acknowledged the degree to which our national economy has become dependent on the financial sector (Finance, Insurance, and Real Estate -- or FIRE). It will do whatever it takes to keep it afloat.

Regarding those deregulation culprits and the apparent misguided repeal of Glass Steagall, former Senator Phil Gramm stands tall and his shadow is dark.

Even so, by 1999 Sen. Phil Gramm (TX, McCain surrogate) -- who had entered the Senate two years after McCain and quickly become the economic guru of the Keating Five maverick -- put forward the Gramm-Leach-Bliley Act. This Act passed out of the Senate on a party line vote with 100% Republican support, including that of John McCain. (To be fair, the bill eventually passed again with a wide margin following revisions in the House.)

This act repealed part of the Glass-Steagall Act. This may sound like a bunch of Congressperson soup, but the gist of it is that Glass-Steagall was put in place in 1933 to control the rampant speculation that had helped cause the collapse of banking at the outset of the depression, and to prevent such consolidation of the banks that the nation had all its eggs in one fiscal basket.

Gramm-Leach-Bliley reversed those rules, allowing not only more bank mergers, but for banks to become directly involved in the stock market, bonds, and insurance. Remember the bit about how S&Ls failed because they didn't have the regulations that protected banks? After Gramm-Leach-Bliley, banks didn't have that protection either.

Gramm wasn't done. The next year he was back with the Commodity Futures Modernization Act, which was slipped into a "must pass" spending bill on the last day of the 106th Congress. This Act greatly expanded the scope of futures trading, created new vehicles for speculation, and sheltered several investments from regulation.

As with both Gramm-Leach-Bliley and Garn-St. Germain, large parts of this bill were written by industry lobbyists. This famously included the "Enron Loophole" that exempted energy trading from regulation and was written by (big suprise) Enron Lobbyists working with Gramm. Not coincidentally, Senator Gramm, the second largest recipient of campaign contributions from Enron, was also key to legislating the deregulation of California's energy commodity trading.